Miller asks Johnson to hedge a hypothetical short position in the floating rate bond in Table 2. Which of the following is the best hedge for this position? A) Buy an interest rate cap. B) Sell an interest rate cap. C) Buy an interest rate floor. Answer is supposed to be A can someone explain why??? I thought that a short position in the floating rate bond made money when interest rate increased and because of this the best way to hedge this position would be to take another position where you would make money when interest rate decreased (like buying an interest rate floor)… but the answer is telling me to buy an interest rate cap… help please!!!
short position in floating rate, your risk is interest rate increase. Price of bond won’t change as it is floating rate bond. to hedge, you need to buy interest rate cap which let you gain when interest rate increase.
thank you francis… the key is that it is a floating rate, if it had been a fixed rate note it would have been different
"short position in floating rate, your risk is interest rate increase. Price of bond won’t change as it is floating rate bond. " Francis, can you explain why price of bond won’t change as it is floating rate bond? Essentially, when we short or long a bond, we are betting on the price movement of the bond, but not the interest rate, right?
price of bond won’t change if it is floating rate. If interest rate rise, coupon payment also rise, therefore, no change in bond price.
where’d you get this question?
schwesser mocks
correction not mock schwesser Q-bank (how do I edit???)